Income tax relief alone can’t spur consumption
The middle class hasn’t seen a Budget like this, at least, in three decades. Everyone expected the Modi sarkaar to give some income tax sops. But no one expected it to be this big.
I have argued in the past that only those with a household income of at least Rs 1 lakh per month, in urban areas, can be called ‘middle class’, even though it places them in the 95th-96th percentile of income earners.
Now, if you earn that much money, you won’t pay any income tax. According to Finance Minister Nirmala Sitharaman, this will put about Rs 6,000 extra in your pocket per month. You could use that to spend more on everyday household goods. Or, you could save up and buy that new smartphone that you have been eyeing.
Those earning Rs 2 lakh per month will get more than
Rs 9,000 extra in their hands every month. That's a significant amount to be spent on daily expenses. Or, on going out and splurging in a fancy restaurant. On an annual basis, they will get Rs 1.10 lakh extra. That could get them the latest 55-inch TV, along with a high-end front-loading washing machine.
In other words, the Modi government is expecting its income tax largesse to translate into a mega consumption boost to the economy. If this works, it will put to rest complaints that India's consumption is slowing down, especially among the urban middle class.
In 2022-23, about seven crore people earned up to
Rs 15 lakh per year. Out of these, roughly two crore paid taxes. If we adjust for pay hikes, after these income tax changes, about 1.5 crore of these will slip out of the income tax net. That means, the number of income tax payers will probably drop to just 1.4-1.6 crore, including those who earn more than Rs 15 lakh per annum. That’s just 4 per cent of our working population.
If that's the case, then the FM's tax projections are a bit hard to understand.
Budget 2025 estimates that income tax collections will increase by Rs 1.8 lakh crore, or 14 per cent in 2025-26 compared to what is expected to be collected in this fiscal. Compared to what the government had projected earlier, it is 21 per cent higher.
This does not sit well with Sitharaman’s claim that the income tax sops will cost the exchequer Rs 1 lakh crore in revenue ‘foregone’. That means, if the old slabs and rates had continued, the government would have collected 22 per cent more in income tax, compared to what it expects to collect this fiscal!
The only way this is possible is if personal incomes go up sharply next year. There are no signs of that happening. In fact, AI and other forms of automation are likely to reduce white-collar jobs in the coming year. If that happens, white collar pay will stagnate, or even fall.
Take the case of someone who is earning Rs 12 lakh per year right now. The new income tax rates mean they will save Rs 70,000 in taxes and end up with that much extra to spend on goods and services. But what if they have to take a pay cut of 10 per cent? Then, the tax rebates won’t help. Their actual consumption will still fall.
In fact, there’s a grave danger of that happening if the economy slows down even further. That could well happen, because the government is slowing down its own expenditure. This year, it spent 6.1 per cent more than last fiscal. Next fiscal, it intends to spend just 5 per cent more. In real, inflation-adjusted terms, the difference is even higher, because the GDP deflator, which is a mix of wholesale and retail inflation, is likely to rise from 2.8 per cent to 3.5 per cent. So, real government expenditure is likely to go up by just 1.5 per cent compared to 3.3 per cent in 2024-25.
This is in stark contrast to what we have seen in the past few years, when government spending on roads, highways and other infrastructure drove GDP growth. In fact, capital expenditure is projected to go up by just 1 per cent compared to what was budgeted last year. In real, inflation-adjusted terms, the government will spend less on infrastructure next year.
That means, all the industries which feed the infrastructure sector — steel, cement, bitumen, heavy earthmoving machinery and even banks — might see a contraction in demand. If that happens, they will want to reduce their wage bill. That, in turn, will affect middle-class incomes.
In fact, the government's corporate tax projections suggest that it is not overly optimistic about corporate earnings. Corporate taxes are estimated to increase by 10.4 per cent next year, which is broadly the same as the government's projection for nominal GDP growth.
It is important to note here that the government failed to collect the corporate taxes it had budgeted for in this fiscal. It had hoped to get Rs 10.2 lakh crore in corporate tax, but is ending up with just Rs 9.8 lakh crore. On the other hand, income taxes have been revised upwards from Rs 11.9 lakh crore to Rs 12.6 lakh crore.
That means, the government collected 28 per cent more in income tax than it did in corporate taxes in 2024-25. Next year, it expects income tax to be 33 per cent more than its corporate tax collections. Surely, this doesn't suggest a turnaround story for the Indian economy.
This is the key problem with thinking that income tax sops can boost consumption without greater investments from the government or the private sector. Leaving more money with the middle class can only generate a temporary spurt in demand for consumer goods and services. If this is not accompanied by widespread economic growth, it cannot be sustained for long.
Right now, India Inc has shown no interest in increasing investments. Most of its projects are linked to the government’s infrastructure schemes. If that slows down, corporates will further curtail their investments in increasing their productive capacity.
That will bring us back to square one, and the income tax rebates will have made no difference to the economy.